Capital Loss: Incurring a loss is one situation no one ever wants to be in but sometimes such a situation could prove useful. Declaring a capital loss could help you in managing the taxes and their returns.
What exactly is a Capital Loss?
In simpler words. A capital loss is the difference obtained when the selling price is low and purchase price is high causing a loss of the investments for the seller.
The basic rule is that you have a capital loss when you get negative profits from any mutual funds, bonds, stocks or any real estate’s i.e., any investment property ( whose value increases with time ), they can be considered as capital losses. However, the losses from the sales of personal property (cars, houses etc.) will not be counted as a capital loss.
With the knowledge of a few simple rules and strategies, capital gains can be offset by capital losses for personal income tax return management.
There are three categories to this:
1. Realizable losses :
Example: You invest a $100 in June and the price comes down to $50 in November, you incur a loss of $50 which can be counted in as a recognizable loss.
2. Unrealizable losses :
Example: Let us consider the same stock above and assume that you hold on to the same stock for the next year and the stock value has now increased to $75. If you sell this stock, you will incur a loss of $25. You will only be able to calculate the current $25 as losses. The previous loss of $50 wouldn’t be added or calculated to the present capital losses. That $50 would be the unrecognizable loss.
3. Recognizable gains :
Generally all the capital gains in a certain a year are generally taken into account but as for the capital losses there is a specific limit as to how much of losses can be claimed or rather declared in a few cases in an year which can be explained as the overall limitation to losses.
Limitations on Overall Net Losses:
People under different tax brackets have different limits as to how much net loss can be declared.
Let us assume that you are under the 33.3 % tax bracket. You will have $3000 limit. This basically means that you can only declare $3000 over the gain amount as a capital loss for that current year to manage your tax returns.
However, this doesn’t mean that the remaining of your losses go to waste. The remaining amount can be drawn by declaring them in the following year losses. The good thing is there is no limit as to how many years these can be carried forward and declared until the entire amount has been deducted
This is known as ‘Capital loss carryover‘ or “Capital loss Carry forward “
Example: You have a gain of $25000 in 2019 and also a loss of $50000. Hence, in 2019 you will only be able to declare a total capital loss of $28000 ($25000 + the limit of $3000 for that year)
The remaining loss would be $22000 which would then become the Capital loss carryover for 2020. It can be declared and spread over the following years from 2020.
Also, if any other gain is realized before the remaining loss is exhausted, they can be declared against those gains.
For example, assuming that you realized a gain of $18000 in the year 2022. The then current remaining losses you would have is $16000 dollars (as you would declare $3000 in 2020 and 2021 which is $22k – $ 6k = $16k).
You can declare these against the new gain of $18000 you realized.
The Wash Sale Rule:
What is a Wash sale?
A wash sale is a situation when the seller wishes to gain maximum benefits by selling a property which would incur a loss at the end of the calendar year to claim capital losses on tax that year bearing the intent to repurchase it at the start of next year preferably at a much lower price than what they had sold it.
To eliminate such situations, the Internal Revenue Service (IRS), has come up with the wash sale rule which states that – if you buy a substantially identical stock or properties within 30 days before or after you sell the stock at a loss. You cannot declare losses from it to the net capital loss. The wash sale rule is more evidently applicable to Individual stocks.
But, an air of relief would be that any loss realized in a wash sale situation is not completely lost. Such a loss can be added to the cost of the most recently purchased substantially identical property. This addition increases the cost basis of the purchased stocks or properties and reduces the size of any future taxable gains. So, the investor/ seller still receives credit for those losses, but much later.